What 401(k) and IRA Accounts Really Cost You
Many individuals I have the pleasure of working with really don't know their true costs of investing. They get statements and some get invoices, but much of the actual costs are obfuscated to make it difficult for investors (and even financial advisers) to determine how much you're really paying for financial services. According to a recent study by the Government Accountability Office, 41% of Americans believe there are no fees associated with their 401(k) accounts, which is never the case. IRA custodians also lure investors in with offers of free trading that can turn expensive in a moment for investors who don't read or understand the fine print. But the biggest cost can actually be the one that nobody talks about, the compounding effect that fees have on your account over time, as we illustrate in the chart below:
Fees in your 401(k) accounts
There are several different types of fees that could apply to your 401(k). Depending on your plan's decisions, some of these fees may be picked up by your employer, but many plans pass through costs to the plan participants. There are so many different types of fees and mechanisms to combine or hide fees inside other fees that these aren't always as easy to see as you would hope. Below are some common fees that you may see:
Recordkeeping fees. You will almost always pay a recordkeeping fee for your qualified plan account. This will either be a flat dollar fee (e.g. $6), generally charged monthly or quarterly, or an asset based fee that is typically baked into investment costs. If you don't see an overt, recurring fee in your account this is part of your investment costs.
Administration fees. This one is probably the hardest to find and is often paid by your employer. If the plan's third party administrator is a fund company (e.g. American Funds) or insurance company (e.g. Empower), there's a good chance that some of this is included in the investment fees, either directly or indirectly. When this is paid by employers, it's often offset by an asset based allowance from the fund company or insurance company. At times, this is difficult to figure out
Custodial/Trustee fees. These fees generally show as a line item when services are unbundled. When services are bundled (one provider fills multiple roles) this is often lumped in with a different fee.
Investment fees. This is the cost for managing an investment, generally shown as an expense ratio. Investments have different share classes though, and there are big fee differences in these share classes, with indirect revenue streams getting funneled to various providers, This includes 12b-1 fees to commissioned brokers, sub-TA fees to recordkeepers and other promotional fees to TPAs and other providers. To find the amount of your investment fees that are going to pay non-investment related expenses, go to the fund company website and find details for the fund of the same name. Compare your returns to the returns of the lowest cost share class (generally I shares or R6 shares); the difference between them is the indirect provider fees.
Investment Management fees. Many plans engage a 3(38) investment manager to select plan investments. Sometimes, this is the parent company that sends a representative out to meet with you (e.g. Raymond James), sometimes, it's a separate provider (e.g. Mesirow). In either case, this fee tends to show as a line item on your transactions and generally ranges from 0.03% to 0.05% of your balance each year.
Investment Advisory fees. This is the fee for the local adviser. If the adviser is commission based, their fee is part of the expense ratio and tends to be between 0.25% and 1% of your balance per year. If your adviser is fee-based, you would see an overt fee transaction for this amount being pulled on a monthly or quarterly frequency.
Managed Account fees. With all these fees, you'd expect that there would be someone actually managing your account, but there's not. Many plans have optional managed account services. This is typically an opt-in service with overt fee disclosures on the front end, but if you're not sure, look for a specific fee transaction for the service in your account. This is almost always a percentage of your assets.
I know that's a lot to digest! Your costs are the sum of all of the fees that hit your account. Many people assume that if there isn't an overt fee listed on their statement, there are no fees, which is not true; some of the most expensive plans have all the fees buried in investment costs, so you don't see the fees but your returns are reduced, which has the same effect just in a less transparent fashion. This is a pretty big list, but there are additional fees that exist that I didn't cover here and not all fees apply to all plans.
Fees in IRAs
The hard part is done, kind of. While 401(k) accounts are notably more complex, your IRA accounts aren't free either, and they tend to make money in ways that are less transparent. Most broker/dealers advertise some variation of $0 trading fees for IRAs. Since most people hate paying transaction fees for trades, these arrangements can seem appealing. These firms didn't get so big by giving away services for free, so what's the catch?
Transaction fees. When you read the fine print, you'll notice it's only certain types of transactions that are free, others will result in a trading fee to buy and/or sell the security. Many offerings feature select lists of mutual funds that don't have a transaction fee. This slimmed down list includes many proprietary investments as well as investments for firms that often pay handsome fees for the privilege of being on that list. With many proprietary funds having no transaction fee, the firm will earn investment management fees when you buy their funds.
Investment Advisory fees. Often, investors choose to get help from an investment professional to manage their account. Just like the 401(k), advisers can be paid on a commission basis, where their fees are baked into the expense ratios of investments you buy or charge asset-based fees where a percentage of your account (typically 1%-1.5% for retail accounts) is taken in fees. Some advisers, like Transform Retirement, offer flat fee arrangements and hourly fees that can better align the costs with the amount of time spent working on your account.
Investment fees. As noted above, many custodial platforms feature proprietary funds that are managed by an affiliate of the custodian. When you use these funds, you pay an expense ratio to the investment manager, part of which goes to the entity managing the fund and the other going to operational costs.
Spread on cash & cash like holdings. When you have cash investments and/or money market funds you receive interest. The custodian will generally invest the cash and pay you a portion of what they make. The difference is called the spread, which is kept by the custodian.
Managed Account fees. Many custodians offer a service to help you select your investments for an additional fee, generally between 0.25% and 0.40% of your account balance annually. It's usually easy to sign up for this service and easy to forget you have it, so it's not uncommon to end up paying multiple people for similar services.
How You Can Manage Fees
Pay your adviser directly. When you have fees taken from your account, you don't see how much the fees are growing but you are very aware of them when you pay fees from your checking account. If your grocery bill increased over 10% a year, you'd notice it, but many investors don't notice their advisers fees doing the same thing because it doesn't impact their current cash flow. Shifting payments away from your account helps you pay more attention to how much you're paying and reap the benefits of compounding.
Use of low cost investments. Too many investors use expensive mutual funds when there are lower cost investments available that can accomplish the same thing. The availability of low cost ETFs on most IRA platforms gives investors the ability to materially reduce investment costs.
Consolidate your accounts. If you have 3 different 401(k) accounts, you've got 3 different sets of fees. By consolidating these accounts, you can eliminate duplicative charges and reduce the risk of losing track of an account. Just make sure you're consolidating to a low cost option!